Used to be you picked the transfer agent who had the most efficient system for maintain records of shareholder accounts, calculating and disbursing dividends, mailing shareholder statements and sending out tax notices.
No more. In 2011, taxation is supplanting technology as a determining factor in what transfer agent to sign up with, if your existing contract is running out.
In the past, "it would be kind of an operations exercise,'' says Stevie Conlon, senior director and tax counsel for Securities Tax Solutions at Wolters Kluwer Financial Services. "Does the transfer agent have the technology and tools to track my holders and handle things? Taxes were a small component."
Rules on reporting of the original cost of mutual funds that investors have acquired. Or, really, the so-called cost basis for any security that has been acquired.
In the past, the Internal Revenue Service only required that brokers report the proceeds of a sale on a 1099 form. This year, the cost of a security will have to be reported, not just the proceeds. Next year, the original cost of shares in a mutual fund will have to be reported. This is designed to make it impossible for a taxpayer to cheat on taxes owed for capital gains.
And the nuances will make this a potentially decisive factor, at this point, in selecting a transfer agent that will keep reliable track of what shareholders choose to do. Because there are multiple methods for calculating the original cost of a 100-share lot of shares. And, for each lot, an investor will have three days after closing a position to declare the method used for calculating the cost of each lot.
Taxation, until now, wasn't a significant factor in picking a transfer agent. Or the number of methods of calculating the cost of purchasing a mutual fund.
"Up until now, if I offered you one method and it was a take-it-or-leave-it, that was good enough,'' said Conlon. "Now, it really matters."
Under the new regime, mutual fund companies have to make sure that a transfer agent can handle a wide variety of options that will be given to investors on picking which lots they are selling.
There are three basic methods: FIFO, averaging and Specific ID.
The first method is perhaps the most well-known principle in inventory accounting: First In, First Out. That simply says that the first lot of an asset that was purchased is the first lot sold.
The second method is nearly as straightforward: averaging. The average cost is the purchase price of all shares divided by the number of shares owned, at the time shares are sold.
But even this is not as simple as it sounds. Averaging, as Conlon points out, is only allowed for shares of stock in a regulated investment company - and stock that, at the same time, is part of a dividend reinvestment plan (aka, a DRiP).
That makes it important for a mutual fund company to make sure that a transfer agent, in this new era of taxation, is able to determine if a given company is a regulated investment company and if the stock in question is inside, not outside, a dividend reinvestment plan.
But the one method that, by Conlon's assessment, "is really getting all the attention" is Specific ID.
And that's because it's not one method. It's a catch-all for any method of accounting for the original cost of an investment that is not FIFO or averaging.
This could be lowest-in, first-out; highest-in, first-out; minimum tax, or, any other method that is embedded in a formula that can be automatically repeated in an algorithm designed to execute it.
"Tracking all the lots, then giving the multiple options for choosing how they receive it" is becoming a "paramount" consideration in picking a transfer agent, said Craig Hill, vice president for sales and marketing at Boston Financial Data Services. "People can switch how they get it and what the method is. It's not straightforward. It's turned into quite a complicated process."
And nothing else in the transfer agent selection process, at this moment, "packs the wollop of cost-basis accounting,'' he said.
Which means that transfer agents have to upgrade their accounting and reporting systems. Or lose out, when contract time comes.
"Either this transfer agent can accommodate the method I want to use or they'll agree to do the development work to accommodate the method I want to use or I am not going to use them,'' said Conlon.
There are other tax rules lurking in the background, such as the Foreign Account Tax Compliance Act, which imposes withholding taxes on United States taxpayers who make payments to or execute transactions with foreign entities that don't meet certain tests. And there will be new rules coming from other legislation, such as the Dodd-Frank Wall Street Reform Act.
But that doesn't mean that taxation considerations have totally trumped the importance of serious automation on the part of transfer agents who matter.
"Technology is critical,'' said Conlon, "because it seems unworkable that that process can be done manually. It has to be automated."
One transfer agent, Computershare, for instance, has started to deploy a two-dimensional avatar, like those used in video games and some computer communities, to provide a "more human-type interaction" with mutual fund shareholders, according to Tyler Haynes, who manages Computershare's closed-end fund clients.
The avatar, named Penny, handles such questions from shareholders as "how do I sell shares?," or "how do I transfer shares to another person?"
And the avatar, named either after the metallic piece of money or a former Computershare chief technology officer, represents exactly the kind of technology that transfer agents need to deploy to differentiate themselves.
A mutual fund company at this point, says Hill, wants to have "self-servicing tools to where a shareholder does not have to call in and talk to the phone, the call center, because that is an expensive exercise.''
"You want them to be able to go and do things all hours of the day and perform tasks instead of contacting people that are sitting in a building somewhere answering phone calls,'' he said.
But tax knowledge and technical skill still might not be enough. These can be "commoditized components for selecting a transfer agent,'' said James Pasman, head of Americas Distribution Services, J.P. Morgan Worldwide Securities Services, which serves 23 mutual fund companies.
The question to ask, he says, is "what is the value that this transfer agent brings that is sustainable over time and predictable over time."
That may start with tax accounting systems and technology. But, he says, it ends with how well the transfer agent can help a fund company increase distribution of its products, satisfy shareholders and create loyalty with the firms that sell its products and the customers who buy them.